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Balance of Payments Accounting. The Balance of Payments. Recall the open economy accounting identity: Income = Expenditures Y = C + I + G + NX Trade Deficits imply NX< 0 Therefore, Y- (C + I + G) = NX < 0
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The Balance of Payments • Recall the open economy accounting identity: Income = Expenditures Y = C + I + G + NX • Trade Deficits imply NX< 0 Therefore, Y- (C + I + G) = NX < 0 Trade deficit countries are spending more than they earn (borrowing from the rest of the world)
Balance of Payments Accounting • Anything that we buy or sell to the rest of the world must be paid for. • The current account (CA) tracks the flow of goods and services between the US and the rest of the world • The capital & financial account tracks the payments for those goods & services (KFA) CA + KFA = 0
The Current Account • Any transaction that represents a flow of funds out of the US is represented by debit (-). Transactions that represent a flow of money into the US are represented by a credit(+) • Net Exports of Goods and Services Exports (+) Imports (-) • Net Income From Abroad (NFP) Income Earned by US nationals abroad (+) Income earned by foreign nationals in the US (-) • Net Unilateral Transfers Payments from foreign countries (+) Payments to foreign Countries (-)
The US Current Account: 2003 (in Millions of $s) Exports of Goods, Services, and Income Goods: $ 713,122 Services: $ 307,381 Income Receipts: Investment Receipts: $ 291,354 Employee Compensation: $ 3,031 Imports of Goods, Services and Income Goods: -$1,260,274 Services: -$ 256,337 Income Receipts: Investment Receipts: -$ 252,573 Employee Compensation: -$ 8,533 Net Unilateral Transfers: -$ 67,439 Current Account: -$530,668
The Capital & Financial Account • Again, any transaction that represents funds flowing into (out of) the US are credits (debits) in the KFA • Financial assets Foreign acquisition of US assets (+) US acquisition of foreign assets (-) • Official Reserve Assets Foreign acquisition of US reserve assets (+) US acquisition of foreign reserve assets (-)
The US Capital & Financial Account: 2003 (in Millions of $s) Capital Account: -$ 3,079 US Owned Assets Abroad (Increase/Financial Outflow (-)) US Official Reserve Assets: $ 1,523 US Government Assets: $ 537 US Private Assets: -$ 285,574 Foreign Owned Assets in the US (Increase/Financial inflow (+)) Foreign Official Assets in the US: $248,573 Foreign Private Assets in the US: $580,600 Capital And Financial Account: $542,680 CA + KFA = -$530,668 + $542,680 = -$12,012
Balance of Payments Accounting • Consider three transactions: • Wal-Mart buys $100M worth of clothing from a Chinese Manufacturer. Wal-Mart pays for the clothing by writing a check drawn off its account at Bank of America. • Warren Buffet collects $50M in interest payments from his financial investments overseas. The Payment is made by crediting Warren’s bank account in London. • Microsoft sells $20M worth of software to the French government. They pay in cash.
Current Account Exports Goods: Services: Imports Goods: Services: Net Factor Income: Net Unilateral Transfers: CA Balance: Capital & Financial Account Foreign acquisition of US assets: US Treasuries: Private Securities: FDI: Currency: US acquisition of foreign assets: FDI: Foreign Securities: Official Reserve Assets Foreign acquisition of US ORA: US acquisition of foreign ORA: KFA Balance: Balance of Payments Accounts $20M (3) $100M (1) -$100M (1) -$20M (3) $50 (2) -$50 (2) -$30M $30M
Tsunami Relief Aid • President Bush recently authorized $350M in aid for the Asian countries affected by the Tsunami. • This will appear in the BOP accounts under unilateral transfers. • Assume we pay this transfer in cash (most likely we would pay by check)
Current Account Exports Goods: Services: Imports Goods: Services: Net Factor Income: Net Unilateral Transfers: -$350M CA Balance:-$350M Capital & Financial Account Foreign acquisition of US assets: US Treasuries: Private Securities: FDI: Currency: $350M US acquisition of foreign assets: FDI: Portfolio Investment: Official Reserve Assets Foreign acquisition of US ORA: US acquisition of foreign ORA: KFA Balance: $350 Balance of Payments Accounts
Balance of Payments and Exchange Rates • Should the Balance of Payments Accounts influence exchange rates? • A BOP deficit (surplus) indicates that financial assets flowing out of (into a) country. Shouldn’t that indicate a currency depreciation? • No really….the balance of payments is an accounting statement. Given the pattern of exchange rates, the BOP indicates the transactions that took place (Remember, by definition, BOP=0)
The US BOP • Consider an alternative form of the national income accounting identity. Y = C + I + G + NX (Income = Expenditures) - Y = C + S + T (Income = Outlays) 0 = I + (G-T) + NX – S S = I + (G-T) + NX (Source of Funds = Use of Funds)
The US BOP • The US is running record trade deficits due to over consumption (US domestic savings is low and the government deficit is large) • Unlike past years, this trade deficit is NOT being financed by foreign private investment in the US, but rather by central banks purchasing US government debt…..this is potentially troubling!